The Record - Governance in Focus | EP2

M Damodaran, Mohandas Pai, and Siddarth Pai explore the critical issues facing young entrepreneurs and startups during public scrutiny and regulatory challenges. They discuss managing public perception and stakeholder confidence by balancing transparency with the need to protect trade secrets.

The conversation also addresses the historical distrust between businesses and regulatory bodies, proposing simpler, trust-based regulatory processes.

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Navigating the intricate dynamics of a boardroom requires subtlety and finesse. The Chairperson, like a conductor, must orchestrate conversations among diverse voices, with varying priorities. A common challenge is the tension between investors and operators. The dynamic between investors and operators requires open dialogue, and the Chairperson's firm guidance. With strategic alignment, open conversation, and skillful mediation, a boardroom can be a harmonious stage for productive discussions.

An advisor plays a critical role in helping startups navigate the complex and delicate relationships with regulators and the Government. They provide guidance on regulatory compliance, help build relationships with key stakeholders, and offer strategic advice. However, the role of an advisor comes with immense power, responsibility, and liability.

As startups face intense public scrutiny, the spotlight threatens not only the startup's reputation, but also affects stakeholder confidence. Amid such disruption, two key questions emerge:

When should a founder seek external aid, without diminishing their leadership?

The need for external assistance arises when a founder recognises the gap between their strengths and the complexities of the situation. Seeking help does not indicate weakness, but rather humility and a commitment to growth. Startups can benefit from having experienced advisors, even if they are not domain experts. They provide a sounding board, and facilitate decisions through constructive conversations.

What lessons can startups learn to prevent erosion of trust?

Startups can learn from a growth phase imbalance between processes, mechanisms, and team alignment. Rapid success often overshadows structural gaps, resulting in breakdowns, when faced with challenges. Maintaining a balance between objectivity and passion is crucial. Decisions must be objective, while implementation can be passionate.

Balancing Independence and Economic Alignment

Independence is a cornerstone of corporate governance, but economic incentives also drive performance. Independence can be skewed when individuals are detached from decision outcomes. Therefore, skin in the game becomes essential—both founders and investors need to be invested in outcomes to ensure responsible decision-making. An advisor's role should incorporate a holistic understanding of all stakeholders' interests.

The question of whether independence is the ultimate solution in corporate governance raises significant economic concerns. When shareholders lack a voice, they often suffer economic consequences without input. The balance between independence and economic alignment becomes critical. Having a strong economic incentive might lead to better alignment between decisions and company interests. This alignment could encourage more circumspect decision-making, benefiting both the company and its stakeholders.

The role of Independent Directors in the boardroom is significant. While they might not have skin in the game, they are appointed for their potential to add value. Independent Directors bring objectivity to the table and play a crucial role in curbing undue optimism, leading to a balanced approach in decision-making. They provide a necessary perspective that ensures acceleration does not lead to a loss of control.

Regulating for Growth

Historically, India's distrust of businessmen is reflected in the plethora of regulations and controls. This has led to an emphasis on Independent Directors and Audit Committees in the corporate structure. However, trusting promoters who have invested time and resources to build companies is essential. Business is often viewed with suspicion, resulting in excessive controls.

Simplifying regulations, writing them in plain language, and introducing sunset clauses(provisions that set an expiration date or conditions for the termination of a regulation) can improve the regulatory landscape. Such measures can foster meaningful governance that focuses on ease of doing business. Balancing regulation with the objective of facilitating business growth is crucial.

High-growth scenarios often lead to an expectation gap. Founders of successful startups are viewed as superstars, raising expectations. Bridging this gap requires creating effective structures, processes, and teams. Honest dialogue, self-assessment, and consultation are vital to managing the challenges that come with rapid growth.

Rethinking Regulatory Philosophy

Addressing the complex dynamics of governance and regulations, especially in a country like India, requires a careful examination of the balance between punishing bad behavior and rewarding good conduct. In a peculiar contrast, India's laws often equate civil mishaps or misdemeanors with criminal acts. The ramifications of such an approach are significant, impacting not only the culprits, but also compliant entities. This skewed approach calls for a fundamental shift in the philosophy underlying regulations.

Moving towards a system that promotes positive behavior instead of just penalising wrongdoing requires a change in perspective. Instances, where isolated cases lead to far-reaching changes in regulations, must be reevaluated to see whether existing regulations could have sorted out the issue. Decriminalisation of Company Law offences is a welcome move since it recognises the need to balance punitive actions with reformative measures. However, progress remains slow, and addressing the root cause of distrust is vital. The penalties imposed should align with the gravity of the offence and aim at reformation rather than retribution.

Transparency vs Trade Secrets

One of the challenges lies in transparency and disclosure requirements, which sometimes clash with the need for confidentiality to protect trade secrets.  Founders must find the right balance between adhering to agreements and maintaining operational secrecy. The approach should be to disclose incidents based on expert opinions to avoid unnecessary panic. Transparency does not always mean exposing every internal detail. Instead, it involves a judicious approach to maintaining stakeholder trust, while protecting sensitive information.

In the context of compliance, routine notices, such as those from tax authorities or regulatory bodies, are an inherent aspect of conducting business. Their frequency often increases with a company's size and success. Here, building a process that involves experts to provide assessments and opinions helps manage perceptions, and temper reactions. Such an approach assures stakeholders that the matter is under control and that expert guidance is being pursued.

As Justice Brandeis put it, "Sunlight is the best disinfectant." However, too much exposure can lead to "sunburn". Transparency is key, but overexposure can harm the process.

Transitioning to a governance model that rewards ethical conduct requires redefining the purpose of regulations, and aligning them with the true nature of offences. Striking a balance between transparency, disclosure, and operational secrecy is possible through expert opinions and well-structured processes. Ultimately, the journey from a punitive approach to a reformatory one necessitates a collective effort from regulators, businesses, and stakeholders, to build a more transparent, trust-based, and efficient ecosystem.

A strong culture of governance stems from an open, transparent, and collegial environment. Founders play a vital role in setting the tone at the top and creating a foundation for good governance.